Interview with Sprott U.S. CEO Rick Rule

Outsider Club Founder Nick Hodge interviews Rick Rule of Sprott U.S.

Outsider Club Founder Nick Hodge interviews Rick Rule of Sprott U.S.

Nick Hodge: Hi, this is Nick Hodge, founder of The Outsider Club. I'm talking today with Rick Rule. He's the president and CEO of Sprott US. Mr. Rule, it's always a pleasure to pick your brain about the resource market, so I wanted to thank you for joining us today.

Rick Rule Sprott Gold Silver

Rick Rule: Always a pleasure, Nick. I appreciate the opportunity. 

Nick Hodge: You've got the Sprott Natural Resource Symposium kicking off next Monday in Vancouver, and ahead of that you've been saying that you're preparing for what you think could be the greatest shift in the natural resource sector that you may ever see in your career. Can you elaborate on what exactly that shift is that you see coming?

Rick Rule: Yeah, absolutely, Nick. Seasoned resource investors understand the extremely cyclical nature of the business. The boomtown and the ghost town are sort of metaphors for the natural resource business. You have very high highs and very low lows. The truth is that they're really related to each other. In this fashion, a bear market becomes the author of a bull market, and the bull market becomes the author of the bear market.

In the last decade, the decade beginning in the year 2000 and ending 2010, we had a monstrous, monstrous bull market. You know, truly epic bull market. Huge fortunes were made, and the consequence of that was that we developed too much productive capacity and the price of resource, many resource commodities, got unsustainably high levels. We had an ugly, vicious, clawing bear market, so the stage was set for dramatic recovery. You've seen the beginnings of that recovery of course dramatically this year in the market for precious metals, gold and silver, and also gold and silver stocks.

I suspect that you'll see a multi-commodity rally in the next year and a half or 2 years where the precious metals and the industrial materials like energy and base metals run simultaneously the same way they did in 2004, 2005, and 2006.

Nick Hodge: What do you like there? I mean, it's a perfect segue to the next question I was going to ask you. What sectors are you looking at in particular? I know you like gold and silver, but do you see opportunities in the platinum group metals and uranium? Then which of the base metals do you like, and is there any particular order to this?

Rick Rule: Well I think right now one is well advised, if one has not yet positioned in the precious metals, to do that. I think that the stage has been set for further moves in the gold price. It doesn't mean that they'll be immediate, but the truth is that the zero interest rate policy (ZIRP) and no interest rate policy (ZIRP) have effectively removed the last objections to owning gold and silver. That is, the rent that you pay on them as opposed to the alternative which you could get in sovereign bonds. I think that the move that we are seeing in gold is probably in the third inning of a nine inning game.

I think you own gold for 2 reasons. You own it to make money of course, but you also own it because of its centuries-old utility in being a store of value. In other words, you own it both to make money and to keep from losing money in the rest of your portfolio, should the broad economy slow down and should the government response become even more radical than it's been in the last two years.

Of course, having filled in the statistical precious metals part of your portfolio, investors and speculators then want to look at the precious metals equities. For investors who are new to the sector, probably the best way to do that is through exchange traded funds, and of course we would prefer that investors consider the Sprott Gold Miners Trust (NYSE: SGDM). Then for the speculative part of your accounts, of course the most dramatic moves that you see is in the juniors. Again, new investors should consider the ETF, and once again, we would suggest the Sprott Junior Gold Miners Trust (NYSE: SGDJ).

Investors who take the time to study, investors who are willing to invest both their time and treasure, as an example, subscribing to newsletters and taking the time to come to conferences and invest in individual stocks, will find that over time they can out-perform most of the ETFs by investing time and treasure in private placements, which gives them A, the underlying stock but of course also the leverage inherent to the warrant, which comes in good private placements.

Nick Hodge: When they go that far, when they're doing private placements, when they're looking at individual companies, what are some of the things you advise they look for? What are the things you look for? Are you looking for junior assets that are heading towards near-term production? Are you looking for prospect generators, mineral banks, pure exploration?

Rick Rule: I think the answer to all those questions is yes. I begin the process now with people. I look for people who have already been successful in pretty much the same activity that they're pursuing now. As an example, if I was looking for a prospect generator, a company that uses their intellectual capital to attract other people's physical capital, I would look to somebody who was already a proven explorationist and a proven explorationist in the commodity they were looking for, in the terrain that they were looking for it in. If they were involved in exploration in Peru, I would want to see that they had already been successful in young volcanic rocks, in Spanish speaking countries, as an example.

What I have found is that you have some people or groups of people who have been serially successful over the last 20 or 30 years. I think you start by starting with the very best people. Then of course I think the next thing that you look for is that you look for potential scale. One of the things that can go really wrong is that somebody might look for a small mine and succeed in finding one. Everything that can go wrong with a big mine can go wrong with a small mine, but a small mine can never make you big money. I really think that you need scale to be in this business.

Of course the most important thing is the value proposition. The value proposition can vary substantially. I say that you never finance a company... You never buy a private placement unless you understand what unanswered question the money will be used for. You invest in these small ventures very much like you would in a research and development technology company. You are investing money that will answer an unanswered question that will unlock some value in the property or the technology that's being explored.

Understanding the unanswered question, understanding what success might be worth, what the probability of success is, how much time it will be before you've answered the unanswered question, what resources will be required by way of cash and does the company have those, that's the heart of the private placement business.

Nick Hodge: You think individual investors can ask management those questions themselves, and you encourage them to do so I assume?

Rick Rule: I absolutely do. Many investors labor under the mis-impression that the companies aren't eager to talk to them. The truth is that a very good entrepreneur is so consumed by his or her venture that they don't want to talk about baseball or TV. They want to talk about precisely what they're doing. It's often very easy to get past investor relations person with the chief financial officer all the way to the CEO because of the passions people have for what they're doing.

The truth is, if you come to our conference or a different conference and you're talking to high ranking officials of the company and they don't want to talk to you, that's a very good sign that they lack the passion that would be required to be a success. That in itself, the fact that you can't get information, can be very good information.

Nick Hodge: Right, every shareholder matters and companies should embrace that. If they're not, it's definitely a red flag.

Rick Rule: I mean, remember yourself when you were beginning to build your publishing business. I remember talking to you. You love to talk about it, you know? It was consuming you, and that's what you want in an entrepreneur. You want somebody who's completely consumed by what he or she is building.

Nick Hodge: I'm still learning. That's why I love conversations like this. How about getting out of a private placement? We just talked about what you look for going into, but now we're at the point where private placements from a month or 2 or 3 or 4 months ago are now sitting up a couple hundred percent. You might have stock available to take off the table or you might have some warrants to exercise. How do you approach those decisions?

Rick Rule: What I do is I have sort of a model in mind, and it's a rough model. Let's say that a company has a very good surface anomaly, that is, there's indications of mineralization taken from surface samples. Let's say that that surface anomaly is a sufficient size, but if it extends to depth, it has the ability to be a fairly large deposit.

The unanswered question might be, "Does the deposit extend to depth?" The proposal, to test the thesis, might be to drill 3 holes. If the 3 holes hit reasonable mineralization - they don't even have to be ore-grade - but if we can see that the mineralization extends to depth and is in sufficient quantity that you might be able to find a good high-grade core, it might be that you think this stock could go from a fifty cent price to a 2 dollar price. You know, that might be your goal.

Of course there's several possible outcomes. The first possible outcome is in a bull market, anticipation of success could be strong enough that the stock goes from 50 cents to a buck and a half or something like that before the drill holes are drilled. In other words, the anticipation of success gives you share price appreciation in a frothy market. In that case, you absolutely sell at least enough stock so that the rest of your stock and your warrants, if any, are free and your capital gains taxes are paid. If you get your price target before the test has happened, you absolutely take money off the table.

The second alternative is that the company drills the holes and they get a yes answer, and your price expectations are met. Then you have a subsequent question to ask yourself. The data that has come to you now must necessarily propose the asking of a second unanswered question. In other words, you repeat the process, but my strong inclination is that if I get a yes answer and if I get the price response that I had expected, again, that I sell enough stock that the rest of my position is free. I call this the point of no concern. In other words, where I have a remnant position, in which I no longer have a financial stake.

The third alternative could be that you get a yes answer, but you don't get the price response in the market. In other words, the value is created, but the market doesn't recognize it. In this case, you buy more stock. You have good information now. They have added value to the company, but the market hasn't been smart enough to respond. In other words, rather than selling the stock that you have, you in fact buy more stock.

Of course the fourth response is that you get a disappointing or a no answer. When you get a no answer, you sell stock, almost irrespective of price. A huge mistake that investors make is buying a stock at a dollar in a private placement, getting a no answer, and then refusing to sell that stock at 60 cents. They say, "If I sell a dollar stock for 60 cents, I lose 40 cents." The truth is, no, you already lost it. All you do is recognize it.

It's important in speculative stocks that your reason to own the stock goes away, that the stock goes away too, and you sell the position and redeploy the capital.

Nick Hodge: That's a phenomenal answer. It's invaluable information for not only a young investor like me but I think anyone starting to venture in to private placements in the resource space, which I think there are a lot of as the market starts to turn a little bit. That would lead me to I think one of my final questions... You've been saying if you stuck around for this much pain that you should stick around for the gain. How far into this bull market do you think we are? Has it started yet? Is it too late? Can you address those sort of concerns?

Rick Rule: Let me give you some really cool statistics, Nick. In the junior market measured by the TSXV Resource Index, I think we were off at the at the trough 88% in nominal terms, so let's round it off in real terms to 90%. This is a market that fell by half and then it fell by half. Then for good measure it fell by half again. The market has recovered by 100%, but a market that was off by 90% that then doubles is a market that's still off by 80%. I expect that over the next 2 or 3 years the index, not the best individual stocks, but the index could increase by 2 or 3 times.

These are phenomenal gains. The truth is that because most investors in the market are so indiscriminate, so uneducated, differentiating between the good stocks and the flotsam and jetsam that are most stocks, is not that difficult for a practitioner that applies himself or herself. The possibility, in fact, the probability exists for somebody who can afford the risk and is willing to invest both their own time and treasure to generate 500% or 600% portfolio gains over the next 2 or 3 years in this sector.

Nick Hodge: That's why I'll be at the Sprott Natural Resource Symposium next week, and I'm very much looking forward to it. I'm encouraging readers to go. We have a banner up on the website. They can click the link at the bottom of this interview, and before I let you go I have to ask, you have some heavy hitters there next week. Mr. Friedland's going to be there, Mr. Beaty. Who do you like to talk to in the resource space? Who do you view as a mentor or who do you take advice from or who do you like talking shop with? Or what are you looking forward to next week?

Rick Rule: I'm not a big picture guy. I'm a guy who is all about drill holes and financials. I like to learn from people whose disciplines are different than mine. One of my keynote speakers is of course Jim Rickards who has been a thought leader in the structure of the economy, and he's made some very bold predictions about the gold price, unsettling predictions because although it will be very pleasant if it comes true for gold investors, it'll be unpleasant for virtually everyone else. Talking to him is fun.

The second thing I really like to do is talk to the guys like Ross Beaty, like Lukas Lundin, like Bob Quartermain, like Robert Friedland who have built billion dollar companies, sold them, and are doing it again. People who have created huge amounts of wealth for shareholders. The third thing that I think is interesting for your subscribers will be ... You know, for many investment conferences, the exhibitors, the public companies who are exhibiting, are regarded as advertisers, and the qualification for a booth is a pulse and a check that cashes, mostly in reverse order. At our conference, our attendees for 25 years have told us that they consider the exhibitors to be investment opportunities, in fact, content too.

What we did, we will not let a public company exhibit unless they are owned in a Sprott managed account where Sprott has a financial interest in the account. That doesn't guarantee that the share price of every exhibitor will escalate over the course of a year, but what it does guarantee is that we know the exhibitors well enough that we've invested our own money in them. Interviewing a list of exhibitors that have been selected by an organization that spends in excess of $3.0 million a year in primary research is a huge, huge benefit to attendees.

The fourth benefit I think is you'll be in a room with 700 high net worth investors who are investing a week of time as well as substantial treasure to come to this conference. The idea that all the knowledge in the room exists on the dais and is sort of handed out to the masses, is silly. There will be knowledge all over the place. You'll be able to walk through the exhibit hall if you want and follow Ross Beaty while he talks to the exhibitors. Those sort of informal exchanges I think are invaluable.

Nick Hodge: Yeah, I think it's going to be great, and it comes at a pretty good time in the markets as well, a time of uncertainty, a time of transition, and a time of hopefully the start of a years-long bull market in the resources. Mr. Rick Rule, president and CEO of Sprott US, I appreciate your time today. I appreciate your time in telling the readers a little bit how you view the current resource markets and expanding how you view handling private placements. I look forward to seeing you next week, and I look forward to the Symposium. Thanks a lot.

Rick Rule: Pleasure sir. I look forward to seeing you there.

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